HOW BUSINESS VALUES NATURAL CAPITAL. Taking Stock and Looking Forward

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1 HOW BUSINESS VALUES NATURAL CAPITAL Taking Stock and Looking Forward

2 How Companies Value Natural Capital Global Nature Fund (GNF) International Foundation for the Protection of Environment and Nature Fritz-Reichle-Ring Radolfzell phone: Responsible according to the German Press Law: Udo Gattenlöhner (GNF) Author: Tobias Hartmann Graphic design: More Virtual Agency Translated by Karen Matzke Status: April 2014 This publication has been funded under the project Economic valuation of natural capital from a business perspective An instrument to internalize corporate environmental impact by the German Federal Environmental Agency and the Federal Ministry for the Environment, Nature Conservation and Nuclear Safety. The responsibility for the content of this publication lies with the authors. Further Information: Acknowledgments: Mathieu Tolian (Veolia Environnement), Ayako Kohno (Hitachi Chemical), Eva Zabey (WBCSD), Mark Weick (Dow Chemical Company), Stuart Anstee (Rio Tinto), Sara Goulartt (EDP), Maria Norell and Karin Hallden (AkzoNobel), Andreas Streubig and Alexander Bartelt (Otto Group), Moritz Nill (Systain), Jan Michler (Stakeholder Reporting), James Spurgeon (Sustain Value), Peter Cruickshank (UNEP FI). Special thanks to Katrina Mead 2

3 Taking Stock and Looking Forward 0.0/ Executive Summary 4 1.0/ Introduction 9 1.1/ What is natural capital? / Economic valuation of natural capital / Limits of economic valuation / The business case for economic valuation of natural capital / Links to existing accounting standards and laws / Links to corporate reporting / Valuation of natural capital in practice / Overview of (international) initiatives / Attitude of business towards the valuation of natural capital / Company examples to date / PUMA s Environmental Profit and Loss Account / Ecological footprint of the Otto Group / 14 road testers of the WBCSD guide / Holcim / Dow Chemical Company and The Nature Conservancy / Experiences and suggestions for improvement / Project-based application as a decision-making tool / Supply chain application / The way forward / Recommendations to companies / Recommendations to policymakers / Conclusion / Bibliography / Annex I: Further resources / Glossary 60 3

4 How Companies Value Natural Capital 0.0 Executive Summary Nature is an essential economic factor. It provides a variety of renewable and non-renewable resources. We use timber as an input factor or food as a consumer good but nature also provides ecosystem services such as water filtration or erosion control that benefit society and economy at once. At the same time economic activity influences the condition and the functioning of nature through the so-called externalities. Neither benefits nor costs are adequately reflected in corporate accounting like the balance sheet or the consolidated profit and loss account. Pilot projects such as the The Economics of Ecosystems and Biodiversity (TEEB) studies, initiated by the European Commission, aimed to highlight the value of ecosystem services and biodiversity for the society and provided new arguments against destruction and overuse. Lately, the private sector has increased its efforts to measure and evaluate environmental costs, and in the longer term to incorporate them into accounting. At the beginning of 2011, chemicals group Dow Chemical and the environmental organization The Nature Conservancy announced plans to join forces with the aim to promote the integration of the value of nature into business decisions. The goal is to collect and evaluate all ecosystem services, from which the company is benefiting, and to incorporate the results into the operations of the company. 1 Furthermore, the World Business Council for Sustainable Development (WBCSD) has published the Guide to Corporate Ecosystem Valuation (CEV) in spring companies, including Hitachi and Veolia, tested the approach presented in this guide: the economic valuation of natural capital as a possible support of decision-making processes. The focus laid on evaluating production or management options, as well as collecting experiences with the new tool. Also in that same year, PUMA published the world s first environmental profit and loss account (EP&L). The calculation focused on five environmental effects: Water and land use, greenhouse gas and air emissions as well as waste production. PUMA took the entire supply chain including the commodity production into account, resulting in external environmental costs of 145 million. This corresponded to around 70 % of the company s profits in This study aims to support this development by informing companies about the status quo of the discussions, existing approaches, methods, and case studies. The study can also serve as an initial guide to those companies who want to implement their own valuation projects. In the long term, the objective is to create a robust, general, and applicable framework for the economic valuation of natural capital in the corporate context. Further, recommendations are made on how existing methods could be improved, and on how policymakers can set incentives to accelerate the integration of this instrument into the corporate world. 1 (Dow Chemical, 2011) 4

5 Taking Stock and Looking Forward THE BUSINESS CASE Numerous reasons exist why companies should deal with the topic natural capital in general and more specifically the economic valuation of natural capital, e.g.: Identification of hotspots in the supply chain and risk management: The economic valuation as part of PUMA s environmental profit and loss account was used to identify environmental hotspots, in this case the production of leather, in the supply chain. Potential disruptions, due to environmental damages or resourcescarcities can therefore be avoided and sustainability initiatives can be targeted more efficiently to where they have the biggest impact. Reputation and consumers: In times of increasing awareness for sustainability and environmental issues, environmental damages are a reputational risk. Economic valuation permits to compare the sustainability performance of two products or companies. With this increased transparency, sustainability can become a competitive advantage. Value for society: Many companies, especially industries with a major direct impact on nature, such as extractives, use the economic valuation to highlight the benefit they are creating for society due to rehabilitation of the sites. The valuation is thus a tool to strengthen the social license to operate. Unified metric: Monetization allows to compare different environmental impacts such as hectares of land use or tons of nitrogen emissions as they are translated into one unit. Therefore, integration in corporate decision-making tools such as cost-benefit-analysis is possible. CORPORATE EXAMPLES Supply Chain application: PUMA and Otto Group The environmental profit & loss account (EP&L) by PUMA should not only be understood as a financial report. Rather, it is meant to facilitate a hotspot analysis and to support PUMA s decision-making process. The company proceeded in two stages: First, various environmental impacts along the entire value chain were quantified. In addition to the corporate properties, the supply chains were examined across several stages, including the production of raw materials, such as leather or cotton. The assessment of the environmental impact for the first tier of the supply chain is partly based on primary data acquisition. For the analysis of the other sections, an econometric input-output model is used. It combines environmental data and trade flows. Through modeling, the environmental impact of the company was subsequently quantified. Five environmental indicators have been selected for the analysis: water consumption, greenhouse gas emissions, land consumption, air pollution, and land use. As a second step, PUMA carried out an economic valuation and calculated the costs of the various environmental aspects. When undertaking the monetary valuation, PUMA relied on the benefit transfer method, where data and values are taken from existing literature and transferred to the case at hand. Methodologically, the Otto Group s procedure to calculate the environmental footprint is quite similar to PUMA s approach. The external costs add up to 10% of the total sales of the group. Major external costs are caused by the emission of CO 2, water consumption, and air pollution. The calculations highlighted that the production of textiles is the main contributor to the environmental damage. 5

6 How Companies Value Natural Capital Project-based application: WBCSD Roadtester and Dow Chemical The WBCSD s Guide for Corporate Ecosystem Valuation sets out five steps how companies can economically capture their positive and negative relations with the environment. The approach differs from PUMA s work, because it covers very specific questions and decision problems. It is therefore not a comprehensive analysis of the company, but an assessment of a certain project or technology. For this reason, attempts are made to rely to a larger extent on local data. Holcim whose example is described more detailed in the study uses the tool to assess the value created for society after the rehabilitation of three gravel pits in the UK. Dow Chemical at the same time conducts an analysis of natural capital management at different production sites. Here, for example the costs of technical solutions to reduce air pollution are compared with reforestation programs, which can provide additional benefits in the form of carbon storage and the creation of habitats. EXPERIENCE AND RECOMMENDATIONS Recommendations for companies: project-based application The biggest challenge is the availability of data. If companies can draw on their own data, the costs and workload decrease. However, particularly data on environmental impacts outside the corporate boundary is often unavailable and must be collected from external sources with great effort. Thus, many of the delays and increased costs experienced by the pilot companies could be traced back to this quantification of the environmental impacts. The independent verification of the calculations and the objectivity of the data are also recurring issues. For this reason, the use of market prices has a particularly high appeal: they are tangible and comprehensible for everyone. That way, the results become less contestable. At the same time, market prices are only available for a small share of ecosystem services. But, many aspects such as landscape beauty or potential revenue sources in the future ( option values ) can hardly be covered. Striking a balance between the precision of the results and the costs is critical and needs to be considered carefully by each company. This decision strongly depends on the audience that the company intends to target with the economic valuation. Great care must be taken, and the results should be well justified, particularly when addressing external stakeholders. Recommendations for progression and application of the project-based approach Identification of the most relevant ecosystem services: Companies should seek a close collaboration with local NGOs and stakeholders, which can help them identify the environmental impacts and dependencies most relevant to the companies. Improvement of the data basis: Companies should begin to collect their own data concerning their impact on the local environment. Government and academia can contribute by developing a publicly accessible database with contextual information about preferences and environmental impacts. Support for a unified corporate approach: More pioneering companies are needed for the further improvement and refinement of corporate ecosystem valuation. As a first step, smaller initiatives can be started and certain environmental aspects could be considered. Building on this experience the approach could be scaled-up to a company-wide method and convention that decreases the cost and effort needed to conduct these studies and to improve comparability of results. Recommendations for companies: Supply Chain application The biggest challenge for the analysis of environmental costs along the supply chain is the design and selection of the underlying economic models. As a result of an expert 6

7 Taking Stock and Looking Forward review it was recommended that PUMA increases the share of primary data in their calculations, so that local conditions and impacts are accounted for. Here as well, the availability of data for the quantification of environmental impacts is the one hurdle that has to be overcome as fast as possible in order to expedite natural capital accounting. Moreover, there is further optimization potential within the models applied so far. Additional environmental impacts, such as water pollution, need to be integrated, and other assessments have to be refined. In addition it is sensible to look more closely at the methods of life cycle assessments, which could help to increase the robustness of the natural capital accounting methods. Drawing a conclusion on the adaptation of the approach by other companies, the experts of the review panel consider it unlikely that many companies will follow the example, as long as an easy-to-apply and less complex method does not exist. The harmonization and standardization of approaches can also lower the entry threshold, and be an incentive for companies to try out an EP&L. Recommendations for the development and application of the supply chain approach Improvement of the data basis: Companies should increasingly collect data on consumption, emissions, and other environmental impacts along the supply chain. For the implementation, supplier questionnaires can be introduced or expanded. It also would be conceivable to carry out natural capital audits in order to verify the data. Development and expansion of the models: Other environmental impacts, such as water pollution, should be integrated into the models. Also, it should be examined whether the indicators currently used, e.g. hectares of land use, are suitable to represent impacts such as the loss of biodiversity. A comprehensive set of environmental impacts should be developed, so that companies can carry out a rough analysis of all possible harmful effects, as a first step. As a second step, the most relevant effects should be studied in a detailed analysis. Recommendations to policymakers The economic valuation of natural capital should be seen as a first step towards the internalization of positive and negative environmental impacts of companies. Policymakers makers have to engage at different levels to push on and accelerate this development. Set incentives for the application by other companies: Currently, the economic valuation of natural capital is tested only by a few companies. Even if the topic arouses more and more interest, practical implementation lags behind. Policymakers must therefore create incentives, e.g. in the form of project funding, in order to reward companies who risk venturing forward and despite the shortcomings still present, have a try at the new methodology. On the other hand, this progress should not turn into a competitive handicap, if the company accepts to shoulder costs and effort. Therefore, even the latecomers should be encouraged to catch up with the pioneers, e.g. by introducing new regulations such as in the field of reporting. Harmonization of data collection and valuation methods: Yet, there is no standardized framework stating which environmental effects should be assessed by companies and how they should be evaluated. Currently, corporations can decide in their sole discretion which environmental aspects they deem important and what information they collect. Comparability of results is therefore only rarely given. A harmonization of frameworks should therefore be supported. As a result, conventions are necessary to make estimations reproducible such as the German Federal Environment Agency has done for the consequences of global warming and other specific environmental impacts. This convention can be expanded to include other environmental effects. 7

8 How Companies Value Natural Capital CONCLUSION The great strength of an economic valuation of natural capital is that negative environmental impacts and the value of ecosystem services are translated into a language, which can be easily understood by business leaders as well as by political decision-makers. Also, this standardization helps integrating external environmental costs into corporate decision-making instruments such as cost-benefit analyses and to thus consider them on a level with financial capital. By integrating them into corporate accounting, the overall environmental performance of a company can be disclosed and compared with other companies. This way, products and their sustainability can also be quantified and compared. By continuously improving, and standardizing the methods used to determine and value the relevant ecosystem services, and in addition by expanding the data basis, it will be possible to further leverage the potential. Pioneers such as PUMA, Otto Group, Dow Chemical, and the WBCSD have sparked a dynamic which provides the opportunity to incorporate natural capital accounting and the recording of externalities in the companies. Some companies have already set out to achieve this objective, but the majority of companies still hesitate. If supported by incentives or regulatory measures, they will also address the issues discussed above. A great opportunity to transform the economy towards a green economy would be seized. 8

9 Taking Stock and Looking Forward 1.0 Introduction Nature is an essential economic factor. It provides a variety of renewable and non-renewable resources. We use timber as an input factor or food as a consumer good but nature also provides ecosystem services such as water filtration or erosion control that benefit society and economy at once. At the same time economic activity influences the condition and the functioning of nature through the so-called externalities. Neither of these influences are adequately reflected in corporate accounting like the balance sheet or the consolidated profit and loss account. Above all, the economic valuation of natural capital has for some time been a part of discussions of environmental policy and comprehensive research projects such as ExternE (external costs of energy) have been implemented in the last years and form the basis for many current applications. At the same time, the The Economics of Ecosystems and Biodiversity (TEEB) studies commissioned by the European Commission has put the topic at the center of attention. The total economic value of pollination by insects, for example, is estimated at 153 billion per year. 2 At the same time, in 2008 the 3,000 largest publicly listed companies were responsible for external environmental costs of $2.15 trillion worldwide. 3 A study carried out by the consultancy Trucost estimates the top 100 external costs to reach $4.7 trillion per year. Coal-based power production in East Asia accounted for the largest share of these costs, closely followed by cattle breeding in South America. The dimensions are even more graphic when comparing the average profit margin before taxes without and with costs for natural capital: None of the 20 most important industries would be profitable if environmental externalities were taken into account! For the cement industry, for example, the margin would be -67%. 4 Different approaches for different objectives Lately, the private sector has increased its efforts to measure and value environmental costs and to make their business models more sustainable. Three triggers sparked off the development in 2011: At the beginning of the year, chemicals group Dow Chemical and the environmental organization The Nature Conservancy announced plans to join forces with the aim to promote the integration of the value of nature into business decisions. The goal is to collect and evaluate all ecosystem services, of which the company benefits, and to feed the results into the operations of the company. 5 Furthermore, the World Business Council for Sustainable Development has published the Guide to Corporate Ecosystem Valuation (CEV) in the spring of companies operating on a global scale 7 tested the approach presented in this guide: the economic valuation of natural capital as a possible support of decision-making processes. The focus was on evaluating production or management options, as well as collecting experiences with the new tool. In the year 2011, PUMA published the world s first Environmental profit and loss account (EP&L). The calculation included five environmental effects: Water and land-use, greenhouse gas and air emissions as well as waste production. It took into account the entire supply chain including the raw material production, resulting in external environmental costs of 145 million. This would correspond to around 70 % of the company s profits in (TEEB, 2010a) 3 (PRI Association & UNEP FI, 2011) 4 (Trucost, 2013) 5 (Dow Chemical, 2011) 6 (WBCSD, 2011) 7 The 14 business studies were conducted by: AkzoNobel, EDP, eni, Eskom, GHD, Hitachi, Holcim, Lafarge, Mondi, Rio Tinto, Syngenta, Veolia Water, Weyerhaeuser and US BSCD. 8 (PUMA, 2011d) 9

10 How Companies Value Natural Capital These pioneering projects have sparked a variety of initiatives of different, mostly Anglo-Saxon stakeholders who pursue the goal of closing knowledge and data gaps, or of promoting the development of a common methodology for economic valuation. Even though the number of specific business examples is currently relatively limited, two basic approaches and targets can be distinguished with respect to the commitment of the companies. Those companies that use the WBCSD CEV Guide apply the instrument in a narrower context, often focusing on the identification of risks and social benefits of ecosystems which are influenced by certain activities of the company. The chemicals group AkzoNobel for example valued and compared the environmental impact of different production technologies from a monetary point of view. The utility company Veolia Environnement in turn compared alternative options for the use of a plot of land. The level of detail of such an approach is determined by the purpose of the respective study and can therefore be very high. Although not a part of the WBCSD pilot studies, the work by Dow Chemical in particular includes a detailed examination of ecosystem services and resulting benefits in selected locations. Capturing the effects along the supply chain, however, is not or only to a limited extent part of these projects. Other companies, such as PUMA or the Otto Group, therefore employ a broader approach, in which the entire value chain is considered, all the way to the production of the raw materials. They focus on the environmental externalities, i.e. the costs (and benefits) that result from the production of goods. By identifying and comparing the main environmental impacts of the company as explained, this approach is first and foremost used for decision-making. Environmental and social externalities The German Federal Environment Agency defines environmental damages as impairments of health and property as well as the extended environmental damages, meaning the impairments of nature. 9 The approaches presented in this study do not follow a clear definition of environmental and social externalities, but mostly emphasize the environmental damages. Impacts of environmental damage on human health are included by some companies such as PUMA. Social costs like bad working conditions or discrimination are however not accounted for. Social factors will be included in this study wherever it seems useful. Box 1: Environmental and Social Externalities 9 (Umweltbundesamt, 2012) 10

11 Taking Stock and Looking Forward The term natural capital accounting is today often applied to describe these two approaches. They have, despite being different in the details, in common that in the long term they both aim to integrate a natural capital in the corporate balance sheets. The plans of the politicians Companies that already deal with this issue at present will benefit from a competitive advantage, as the potential of economic valuation has also been recognized at the political level. The European Biodiversity Strategy notes that monetary valuation can be an important tool in raising awareness regarding ecosystem services and biodiversity. 10 The EU s Roadmap to a resource-efficient Europe states: New policies should help to align the prices of re sources that are not appropriately valued on the market, such as water, clean air, ecosystems, biodiversity, and marine resources. 11 The economic valuation can be used to reveal external effects and increased transparency allows lawmakers and authorities to create incentives for sustainable management or to sanction environmentally harmful behavior with new policy instruments. The most important barrier to the integration of natural capital into accounting is the lack of accepted standards for its measurement and valuation. Harmonized methods are however necessary for a consistent recording of the data which determines the comparability of the results. The effects along the supply chain, in particular, remain a major challenge. 12 companies about the status quo of the discussions, existing approaches, methods and case studies. The study can also serve as an initial guide to those companies who want to implement their own valuation projects. In the long term, the objective is to create a robust, general and applicable framework for the economic valuation of natural capital in the corporate context. At the same time, recommendations are made on where existing methods could be improved further, and on how policymakers can set incentives to accelerate the integration of this instrument into the corporate world. The study will first briefly explain the key concepts (chapters 1.1 and 1.2), clarify the limits of economic valuation (chapter 1.3) and illustrate why it is in the self-interest of companies to begin with measuring and valuing their natural capital (chapter 1.4). Chapters 2 and 3 contain information on how the assessment of natural capital interconnects with the existing standards of accounting and reporting. The fourth chapter presents existing (international) initiatives which are currently active in the area of value natural capital (chapter 4.1). It also gives an overview of the results of a survey on the knowledge and attitude of German companies with regard to the subject of natural capital (chapter 4.2). Methods applied and practical experiences of companies are at the focus of chapters 4.3 and 4.4. Chapter 5 provides an outlook and recommendations to companies (chapter 5.1) as well as policymakers (chapter 5.2). Further information can be found in the annex. This study aims at making a contribution to supporting the development of natural capital accounting by informing 10 (European Commission, 2011a) 11 (European Commission, 2011b) 12 (IFAC, 2013) 11

12 How Companies Value Natural Capital 1.1 What is natural capital? Capital is defined as [...] the inventory of production equipment that can be used for the production of goods and services. 13 With this in mind, the current stock of biodiversity and ecosystems can be defined as natural capital. This stock can yield various dividends in the form of ecosystem services. Hence, a forest rich in species yields various forms of dividends, such as wood, medicinal plants, or drinking water. But also more abstract services, such as the regulation of the climate through the storage of CO 2 in the soil, can be seen as a dividend provided by the forest. Figure 1 gives an overview of the various ecosystem services and its relationship with business activities. From a business point of view, natural capital can therefore be considered an (external) production factor. Thus, it is economically expedient for companies to preserve or increase the functioning and integrity of ecosystems, so that corresponding yields can be permanently secured. In the last 50 years, due to human interventions, ecosystems have changed faster and more extensively than ever before in human history. This was in particular to meet increasing needs, such as for food, drinking water, wood, natural fibers and fuel. Worldwide, 60% of all ecosystem services are affected by this, which means that ecosystems are no longer able to provide their original services or no longer to the full extent. 14 These are the key factors for this development: Degradation of ecosystems and habitats Climate change Environmental pollution Overuse of resources Spread of invasive species Against this background, the signatories of the Convention on Biological Diversity have set the target to significantly reduce the loss of biodiversity by Although some progress has been made, it will be difficult to achieve this goal. Because entrepreneurial activities contribute to the loss of biodiversity, attempts were increasingly made in recent years to motivate companies to protect biodiversity. To this end, numerous initiatives were launched, such as the European Business and Biodiversity Campaign or Biodiversity in Good Company. What is biodiversity? In accordance with the UN Convention on Biological Diversity (CBD), biodiversity describes the diversity of life on different biological structural levels: genetic diversity, the diversity of animal and plant species (biodiversity) as well as the diversity of ecosystems. Diverse interactions take place on and between these levels. These form the basis for numerous ecosystem services, which are the fundamental basis for human well-being. Box 2: What is biodiversity? 13 (Gabler, 2004), p (Millennium Ecosystem Assessment, 2005) 12

13 Taking Stock and Looking Forward Figure 1: Interaction of business activities, biodiversity and ecosystem services CORPORATE ACTION enable ECOSYSTEM AND SERVICES supply of raw materials meeting the wishes of the customers competitive advantages innovations freedom of choice and action affects DRIVERS OF CHANGE land use change overexploitation nutrient load climate change introduction of alien species PROVISIONING SERVICES raw materials genetic resources biochemicals drinking water SUPPORTING SERVICES nutrient cycling soil formation water cycle provision of habitats CULTURAL SERVICES recreation Inspiration knowledge REGULATING SERVICES pollination pest control water purification flood control climate regulation regulation of soil erosion alters BIODIVERSITY basis for important natural processes ecosystems species genetic diversity Source: adapted from (Beständig & Wuczkowski, 2012) 13

14 How Companies Value Natural Capital 1.2 Economic valuation of natural capital For economic valuation the different components of natural capital are important and their benefits as well as damages need to be assessed. To ensure a comprehensive assessment, the concept of choice is generally the total economic value (TEV), shown in Figure 2. In order to determine the economic value of natural capital, various categories of benefits are being considered. The total value results from adding up the individual elements. Use (utility value) and non-use values are differentiated as the main categories. On the next level, use values are divided into consumptive (e.g. consumption of wood or fruit, i.e. the amount usable for other users is being diminished) and non-consumptive values (e.g. recreation, in which the consumption of one person has no influence on the consumption opportunities of another person). These direct value categories are usually the easiest to assess in monetary terms, since existing markets and market prices can be referred to. Use values also include indirect use values. The pollination by bees as a prerequisite for the production of food, for example, is part of this category. In order to account for uncertainties about future benefits, the option value is introduced. It refers to possible advantages and benefits derived from nature in the future, which are still unknown to Figure 2: The total economic value Total Economic Value Use values Non-use values Actual value Option value Philanthropic value Altruism to biodiversity Direct use Indirect use Bequest value Altruist value Existence value Consumptive Non consumptive Crops, livestock, fisheries, wild foods, aquaculture Recreation, Pest control, spriritual/cultural pollination, well-being, research education and purification, water regulation soil fertility Future use of known and unknown benefits Satisfaction of knowing that future generations will have access to nature s benefits Satisfaction of knowing that other people have access to nature s benefits Satisfaction of knowing that a species or ecosystem exists Source: (TEEB, 2010b) 14

15 Taking Stock and Looking Forward date. The tropical rain forest is often cited as an example. It is assumed, that there are hitherto unknown animals and plants whose economic value will only be revealed in the future (e.g. medical use). If the species is lost however, this possible value cannot be realized. These potential losses as well as the lost potential for carbon storage must therefore be accounted for when rainforest is being destroyed, for example through soy cultivation or cattle farms. The so-called non-use values or non-use dependent values are another component of the total value. Many people draw benefits from knowing that certain animal or plant species exist, even if they might never set eyes on them throughout their lives. In addition, cultural and spiritual benefits can be drawn from nature and are included in the TEV as use categories. The question arises, how natural capital components which make no known direct contribution to human well-being or to the economy can be valued economically. These components can be captured at least partially by means of non-use values. Due to the immateriality of these value categories, the figures are difficult to compare, vague and subjective. Methods for economic valuation After presenting the main benefit categories of natural capital, the valuation methodology is the next subject to be considered. Table 1 gives an overview and provides a comparison of the most common procedures. These valuation techniques have different advantages and disadvantages and also differ in their suitability for the valuation of the respective ecosystem services. As mentioned, market prices are being applied in particular to direct values and provisioning services, as actual market transactions can be referred to in order to evaluate the benefits. More sophisticated methods, such as conducting interviews or more complex modeling must be used for services for which no market exists. 15

16 How Companies Value Natural Capital Table 1: Economic valuation techniques TECHNIQUE COMMENT/EXAMPLE DATA REQUIRED TIME (DURATION) SKILLS REQUIRED MARKET VALUATION Market prices Mainly applicable to goods (e.g. fish) but also to some cultural services (e.g. recreation) or regulating services (e.g. pollination) * Market prices of ecosystem goods or services * Production and distribution costs Days to weeks Basic understanding or econometrician Change in productivity How the fertility of soils increases yields and thus the income of farmers, or how improved water quality can foster fishery * Data on production function * Data on cause-and-effect relationship (e.g. crop losses due to reduced availability of water) Days to weeks Basic understanding (potentially agricultural expert or process engineer) Replacement costs The value of groundwater use can be estimated to be the cost of obtaining water from other sources or by using technological alternatives (replacement costs). The cost (market price) of replacing an ecosystem good or service with a man-made equivalent (e.g., replacing flow regulation of habitat with flood defense scheme) Days to weeks Basic understanding Damage costs avoided The value of flood protection can be derived from expected damages associated with flooding. * Data on costs incurred to property, infrastructure or production as a result of loss of ecosystem services * Damages under different scenarios, including with and without regulatory service Weeks Engineering knowledge and knowledge of biophysical processes REVEALED PREFERENCES Hedonic pricing Calculation of price differences, e.g. of properties that can be traced back to different ecological qualities * Data relating to differences in property prices that can be ascribed to the different ecosystem qualities (e.g. number of bedrooms, quality of river, and distance from river) Days to weeks Econometric Travel costs Part of the recreational value of a park is represented by the time and money spent by the visitors in order to reach the park *Average duration of visit and expenses with regard to recreational or leisure activities * Motivations for travel Weeks to months Designing the questionnaire, conducting interviews and econometric analysis STATED PREFERENCES Contingent Valuation (CV) Often the only way to estimate non-use values. For example, participants of a survey can be asked, how much they are willing to pay in order to improve the water quality of a lake, allowing them to swim or fish in it. *Stated value that people place on an ecosystem good or service (e.g., water quality, wildlife in a river); demographic and biographical information on survey respondents *Obtained through survey questionnaires Weeks to months Questionnaire design, interviewing and econometric analysis Choice experiments (CE) It can be used with the help of different methods, for example comparing two options. *As for CV above, although CE contrasts several different scenarios *An appropriate set of levels is required for the different parameters (e.g., poor, medium, good and excellent river water quality) Weeks to months Questionnaire design, interviewing and econometric analysis Benefit transfer Transfer of values or benefits from existing studies with similar context. *Valuations from similar studies elsewhere *Data on key variables from different studies (e.g., GDP per person) Days to weeks Basic or econometric analysis if using bid functions 16

17 Taking Stock and Looking Forward ADVANTAGES DISADVANTAGES + + a readily transparent and defensible method since based on market data + + it can reflect an individual s willingness to pay -- only applicable where a market exists for the ecosystem service and data is readily available -- market prices can be distorted, e.g. by subsidies. + + if data is available, it is a relatively straightforward technique to apply -- necessary to recognize and understand the relationship between the ecosystem service and output of product -- can be difficult to obtain data on both change in the ecosystem service and change in productivity + + provides surrogate measures of value for regulatory services (which are difficult to value by other means). + + a readily transparent and defensible method when based on market data + + provides surrogate measures of value for regulatory services that are difficult to value by other means (e.g., storm, flood and erosion control). -- can overestimate values. - - does not consider social preferences for ecosystem services or behavior in the absence of the services. -- the replacement service probably only represents a proportion of the full range of services provided by the natural resource. -- the approach is largely limited to services related to properties, assets and economic activities. -- can overestimate values. + + readily transparent and defensible method, because based on market data and WTP. + + property markets are generally very responsive so are good indicators of values + + based on actual behavior rather than a hypothetically stated willingness to pay + + results are easy to interpret and explain -- approach is largely limited to benefits related to property. - - the property market is affected by a number of factors in addition to environmental attributes, so these need to be identified and discounted (e.g., number of bedrooms) -- high data requirements -- approach is limited to the direct use recreational benefits - - difficulties in apportioning costs when trips are to multiple places or are for more than one purpose -- considering travel costs alone ignores the opportunity cost of time while traveling + + captures both use and non-use values. + + extremely flexible - it can be used to estimate the economic value of virtually anything. + + gives a much more accurate outcome than benefit transfers. + + captures both use and non-use values + + theoretically provides more accurate values for marginal changes (e.g., values per % increase in coral cover) + + gives a much more accurate outcome than benefit transfers -- the results are hypothetical in nature and subject to numerous biases from respondents: - - e.g., respondents may express a positive WTP to promote a warm glow effect, overestimating the value; -- e.g., if the cost is perceived as a tax, respondents may express a negative WTP, underestimating the value -- it is resource intensive -- the results are subject to bias from respondents and are hypothetical in nature -- it is resource intensive -- it can be mentally challenging for respondents to truly weigh up the alternative choices given to them in the time available + + low cost and rapid method for estimating recreational and non- use values -- the results can be questionable unless carefully applied - - existing valuation studies may be more robust and numerous for some services than for others Source: Adopted and extended from (WBCSD, 2013) and (TEEB, 2010 b) 17

18 How Companies Value Natural Capital The so-called benefit transfer method (value transfer) plays a special role. It was the basis of valuation for PUMA s EP&L and many of the studies carried out by the WBCSD pilot companies. It is not a stand-alone method. Rather, the idea is to take advantage of existing literature and data and to transfer them to similar issues while adapting them as much as possible. For example, calculated values for the flood protection function of a lake in southern England could be transferred to a wetland in the North of England. The calculation of average values or utility functions and their subsequent use is also possible. Benefit transfer is often less expensive than carrying out a separate study, especially when dealing with aspects, for which market prices do not exist. It is self-evident that precautionary measures need to be taken when transferring certain values. The underlying studies have been carried out in a particular context after all and the meaningfulness of the transfer must be verified. When analyzing the willingness to pay, basic socio economic conditions play an important role. The transfer to other regions must take account of these differences and the estimates have to be adjusted by for instance using purchasing power parities. Also, the methodological quality of the underlying study must be ensured, because ultimately, errors contained therein are being transferred and might be multiplied. 15 Still, there is reason to believe that benefit transfer will prevail as the dominant method for the monetary valuation of environmental impacts. This is true for example when the entire supply chain is being examined and separate valuation studies cannot be carried out at each site. In doing so, it has to be ensured that the resolution of the cost and value data be as high as possible. In other words: In order to adapt specific valuations to the local context, the underlying data has to be collected on the same or a similar level of the scale. If this is the case, the local values can be transferred to the new context. Consulting firms such as Trucost or PwC strive to locally adapt their data and have created comprehensive databases, which should simplify more complex applications of the assessment method and increase its robustness. To that end, more data has to be collected in the long term, further studies have to be carried out and models of calculation as well as data bases have to be standardized and made publicly available in order to ensure plausibility and comparability. These attempts of harmonization will simplify the application as a whole, because they limit the uncertainties of the used values to a certain extent. Benefit transfer is not always the ideal solution In many cases, separate analyses cannot be avoided. While greenhouse gas emissions cause global environmental changes, there are pollutants and impacts, such as air pollution, which mostly cause locally limited damages. In the absence of local assessment data, a calculation on the basis of global average values or on the basis of calculations from other regions can easily lead to distortions. Even if a company plans to apply the economic valuation for a specific decision or for a locally limited examination, e.g. for a production site, it is advisable not to opt for benefit transfer. This is because the actual local preferences of the population as well as the structures and functions of the ecosystem cannot be easily replicated by estimates of another study, so that reliable results cannot be calculated. It is advisable to make a greater effort, e.g. analyzing the willingness to pay and therefore achieve more reliable results. 15 The methodological convention of the German Federal Environment Agency provides assistance on how to select a suitable study for benefit transfer. (Umweltbundesamt 2012) 18

19 Taking Stock and Looking Forward 1.3 Limits of economic valuation While the economic and monetary valuation of natural capital offers various advantages it cannot be regarded as a panacea. Recording external environmental costs is the last step in a process that begins with a quantitative analysis of entrepreneurial effects on natural capital as well as its dependencies from it. Such analyses can be the basis for responsible biodiversity management. Companies must therefore ask what added value the monetary valuation of natural capital holds in stock for them. While there is a number of procedures and indicators for the capturing of natural capital, trying to value natural capital and impacts on natural capital comprehensively is highly complex. The following aspects are to exemplify how difficult it is to properly assess the benefits that ecosystems generate. Allocating the impacts: How can negative environmental impacts be assigned to the responsible agent? This problem of causality can be illustrated by the example leather: Starting point of the production of leather is the skin of an animal, which often accrues as a by-product of the production of meat and is subsequently processed. A certain percentage of the environmental damage caused in the meat production would therefore have to be allocated to the leather producers. The environmental costs caused by cattle farms would, as an example, thus have to be apportioned based on the value added. This example also illustrates another difficulty. The conversion of a forest goes through three phases: initially, the forest is being cleared, then the area is being converted into agricultural land on which, for example, soy is grown. Finally, the same land is being depleted by agriculture and used for cattle breeding. The massive impact on nature, i.e. the clearing of the trees, would therefore have been carried out for the cultivation of soy, not for the farming of livestock. This would have to be taken into account when apportioning the environmental costs to the polluters. Spatial valuation differences: Biodiversity and ecosystems are valued differently if the respondent is directly dependent on them, or if they are only present on a different continent. Impacts and valuations vary on local, regional and international levels. One example is the preservation of forests. Forests generate income for the local population, for example, by harvesting forest fruits. In addition, they provide ecosystem services such as erosion control and thus benefit the regional population. Assuming the forest is also a habitat for rare species, whose conservation is a concern to part of the world s population, the ecosystem also generates global benefits. Temporary valuation differences: Even temporal effects play a role. An overuse of natural resources, such as fish stocks, beyond their ability to regenerate, has a strong impact on the availability of these stocks in the future, meaning that the external effects are being passed onto subsequent generations. Similar to the case of investment decisions, it is possible to compensate temporary valuation differences by discounting future benefits. Putting a discount rate greater than zero means that the benefit of future generations is being rated lower than today s benefit. The choice of the discount rate can quickly lead to ethical discussions. Thresholds, tipping points, and irreversibility: Nonlinear dynamics become apparent in the degradation of ecosystems: if certain impacts are too massive, thresholds may suddenly be overstepped, which cannot be undone or only with great effort. Within certain levels of concentration, lakes for example can absorb nutrients without their self-cleaning function being significantly affected. The closer the system gets to its pollution load capacity, the more the self-cleaning power of water is affected. Once set in motion, these dynamics cannot be stopped anymore and the system collapses. In the case of a eutrophying lake, any costs for the introduction of a nutrient unit would therefore have to gradually rise according to their damaging impact and tend to infinity just before reaching thresholds. 19

20 How Companies Value Natural Capital 1.4 The business case for economic valuation of natural capital For companies, there is a variety of reasons to deal with the subject of natural capital in general and with economic valuation in particular. Table 2 gives a brief overview. Firstly, the economic assessment of natural capital can lead to improving internal processes and decisions. Generally, it can be said that improvements of corporate transparency can be achieved and optimization potentials can be revealed. With a cost-benefit analysis, the environmental impacts and the accompanying (external) costs of different production technologies can be evaluated. The Japanese company Hitachi 16 did this for the CO 2 emissions of selected technologies for the manufacturing of electronic components. The company calculated, which costs the company might be facing and how, if necessary, environmental taxes could be saved. In addition, possible savings can be pointed out, for example when comparing ecological approaches to erosion control through reforestation with an alternative technological solution. 17 Similarly, companies can use their funds more precisely to address the identified damaging impacts at ecological hotspots. Accordingly, PUMA has decided to seek alternatives to leather, as the leather production is responsible for the bulk of the company s impact on the environment. 18 One special value added by economic valuation is the fact that the value of natural capital is expressed in a comparable unit. These examples show that integrating natural capital in corporate management tools, such as cost benefit assessments, provides companies with a basis for decisions that can make a significant contribution to improving the environmental performance of companies. Table 2: Reasons for the economic valuation of natural capital PROCESS OPTIMIZATION + + Decision making: ecological advantages and drawbacks of alternative production techniques can be assessed. + + Potential savings can be identified and expenses for environmental taxes can be reduced. + + Investment decisions can be targeted more accurately. + + Increased transparency through increased knowledge. RISK MANAGEMENT + + Allows companies to respond to new laws at an early stage. + + Liability and compensation costs can be estimated more easily. + + Potential risks in the supply chain can be diagnosed and solved more easily. REPUTATION + + The environmental performance of a company can be demonstrated and compared with competitors. + + Companies can position themselves with respect to competitors. + + A positive image can induce increased demand by consumers. + + Employees identify more closely with their company. BUSINESS OPPORTUNITIES + + Potential new business opportunities such as eco-tourism and biodiversity offsets can be evaluated and applied. Source: Own illustration 20

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